A stop loss order, or a stop order is an advanced trade order with your brokerage that specifies your intention to execute a trade only when a specified price level has been reached. The difference between a stop loss order and a conventional market order is that, in the second option; the investor simply specifies that they would like to execute a trade at the current trading price of the stock in question.
How does it work?
A stop loss, quite simply, is an automatic trade order that your brokerage is allowed to execute on your behalf. This is possible only if the price of your stock falls to a certain stop price specified by you. It is designed to help limit your losses in a position of security.
Take our investor friend Rajneesh for instance, he has invested long in 10 shares of Tesla (TSLA) at $320 per share. He is heading off to Bali for a week-long vacation and would not be able to check the markets to determine his stock’s position. Rajneesh does not want to return to find his stocks to be worthless out of circumstances. At its current price, TSLA trades for $350 and he does not want to lose out on any unrealized gains while he is away. So he sets up a stop loss order with his brokerage at a price of $345. If the price of TSLA stock falls below $345, then his stocks are sold on the market, when it hits his stop price. By doing this, Rajneesh limits his losses to just $5 per share. He is free to enjoy the beaches of Bali knowing that he has secured his losses, still making a profit of $25 per share.
Similarly, instead of watching the stock price for days at end, you can simply place a stop loss order with your brokerage to sell your stocks if it falls below a certain price in the stock market. The only risk with using a stop loss order involves being stopped out of a trade that would have been profitable, or more profitable, if your risk management strategy had a higher threshold.